IBG - Political Economy and Economic Development s2 2014

Political Economy and

Economic Development

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Lecture Topics

• Economic Endowments • Macroeconomic Stability• Economic Development• Economic Systems• Economies in Transition• Managerial Implications

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Economic Endowments–Size–Natural and created resource

endowments associated with its geography–People– Infrastructure –Competitiveness

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Size - Gross National Income (GNI)

GNI is the value of a nation’s income, ie the income earned by the residents of the nation

GNI doesn’t matter where the income is earned, in the domestic market or a foreign market

GNI equals GDP plus net income from abroad.

GNI per capita is a common measure of economic development

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Geography– The natural resources and features of a

country affect the level and patterns of market demand and production.

– Geographic features such as the endowments of accessible mineral deposits, climatic patterns, the distribution of soil types and the topography of a region provide or limit business opportunities

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People– The population characteristics of a country help

define its market potential or its potential as a location for production

– Market analyses of population size and growth and population distributions can provide general indicators of the potential market size for a firm’s product

– One thing that is happening globally is the so-called ‘demographic divide’ which shows major shifts across countries and within countries and the second is an aging population profile

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Net Overseas Migration (000’s)

1-7

2006

–07

2005

–06

2004

–05

2003

–04

2002

–03

2001

–02

2000

–01

1999

–200

0

1998

–99

1997

–98

1996

–97

1995

–96

1994

–95

1993

–94

1992

–93

1991

–92

1990

–91

0

50

100

150

200

250

457 Visa Applications Granted Since August 1996, 000s.

1-8

1996/97

1997/98

1998/99

1999/00

2000/01

2001/02

2002/03

2003/04

2004/05

2005/06

2006/07

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

Permanent Visa Outcomes by Migration Program, 1997-2006, (000’s).

1-9

0

20000

40000

60000

80000

100000

Skill stream Family stream Humanitarian Program

Population debate• The worlds population expect to increase by 50% by 2070

which is an extra 3 billion people• Can Australia simply shut its borders down• How many people can Australia accommodate and at what

rate can we grow• What are the opportunities that come with population

growth and what are the sacrifices• http://www.youtube.com/watch?v=8KgqDzBCAnU

1-10

Infrastructure

• Infrastructure refers to the created assets of an economy that facilitate business.

• It includes the physical structures such as transport, energy, communications, financial and legal systems

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Competitiveness and ProductivityExternal sources: Quality infrastructure,

country of origin effects, and external economies arising from the firm’s operation in a large and successful industry or cluster of successful industries in a country or region

– firm’s competitiveness depends on three key elements: price of inputs, productivity and the foreign exchange rate.

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Major Productivity Determinants

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Macroeconomic Stability

–occurs when an economy grows without persistent and major fluctuations in the levels of economic activity, inflation rates, unemployment and balance of payments–This measure focuses more on the state of the

current economic conditions of an economy.–Current economic conditions reflect the stage

of the business cycle.

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Business Cycle– refers to the tendency of economies to

move in sequence through phases of expansion and contraction of economic activity in a somewhat regular pattern.– In pursuit of social, political and

economic goals, national governments attempt to stabilise the economy.

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16

1-17

-3

-2

-1

0

1

2

3

4

5

6

Recession

Recession

Gross Domestic Output, 1981 – 2009

Unemployment Rate, per cent

0

2

4

6

8

10

12

1960 1970 1980 1990 2000 2010

Costs to the economy as a whole.• Loss of Gross Domestic Product.• Loss of human capital.• Re-training costs.• Unemployment benefit payments are a net drain on

federal budget.• The opportunity cost of funds directed towards

unemployment benefits. • Loss of tax revenue – personal income tax,

company tax, GST and excise taxes.

The costs of unemployment

Costs to the unemployed people.• Loss of income.• Loss of skills.• Re-training costs.• Loss of self esteem.• Unemployment may contribute to family break-

ups, health problems, mental illness, crime and political unrest.

The costs of unemployment

Inflation • Inflation is a process in which the price level is

rising and money is losing value.• Inflation is not the increase in the price of one

item.• Inflation is the increase in the price of all items by

similar percentages.• A one-time jump in the price level is not inflation.• Inflation is an ongoing process.

The CPI Market Basket

Inflation Rate, per cent

0

5

10

15

20

1970 1980 1990 2000 2010

Costs of Inflation

• Individuals- Borrowers or lenders of money may lose- Real wages may fall- Reduces purchasing power of those on fixed incomes

• The economy- Export and import effects- Investment effects- Tax bracket ‘creep’ effect may reduce real incomes- Uses resources, e.g. shops changing prices or wages

Inflation– Interest rates are likely to rise with inflation.– High inflation can lead to the depreciation

of the value of a currency, which implies consequences for international business

– High rates of inflation can hinder the long-term development performance of an economy.

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External Viability & Debt –The external viability of a country is an

important variable for business to monitor when assessing the economic conditions of a country.–Whether or not a country is able to pay its

way internationally can affect the market or investment potential of the country.

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Balance of Payments

– The Current Account records the ‘current’ expenditures on transactions.

– The Capital Account records international capital transfers.

– The Financial Account records the financial flows and balances arising from capital transactions.

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Economic Growth• Refers to an increase in the productive

capacity and national output of a country, measured by the rate of increase of GDP

• Sources of economic growth include:the availability of more resources; the factors that lead to the more productive use of those resources such as increased labour skills, new technologies, innovative products and expanding markets and scale economies

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Policy objectives

• Full employment• Stable price level• External balance• Economic growth-trade offs and constraints

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Instruments• Monetary policy– involves the manipulation of interest rates and the

money supply by the nation’s central bank for similar purposes

• Fiscal policy– involves making adjustments to government

expenditures and taxes to stimulate or slow down economic activity

• Exchange rate• Interdependence of Policies and Lags

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Economic Development• Multi-dimensional concept• Refers to the increasing capacity of an

economy to improve and sustain the standards of living of the entire population.

• It includes notions of process, change, inherent dynamism, independence, sustainability and the long term.

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Differences in Economic Development

–Different countries have dramatically different levels of economic development.–One common measure of economic

development is a country’s gross national income per head of population.–Although there are a variety of measures

of economic development

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GNI per Capita in US Dollars

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Purchasing Power Parity

– GNI per capita figures can be misleading do not consider how the income is distributed or differences in the cost of living.

– Purchasing Power Parity (PPP) is an adjustment in gross national income per capita to reflect differences in the cost of living

– PPP allows for a more direct comparison of living standards in different countries

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Purchasing Power Parity GNI

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Human Development Index

–different perspective on development (Amartya Sen) –development should be more by the

capabilities and opportunities that people enjoy–HDI measures the quality of human life

in different nations

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Human Development Index

– based on three measures: i. Life expectancy at birthii. Educational attainment (adult literacy rate and

enrolment in primary, secondary and tertiary education)

iii. Whether average incomes, based on PPP estimates, are sufficient to meet the basic needs of life in a country

Less than 0.5 low human development 0.5 to 0.8 medium human developmentAbove 0.8 high human development

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Human Development Index

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Economic Systems

• Market economy

• Command economy

• Mixed economy

• Economies in transition

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40

0 5 10 15 20 25

Sweden

France

EU 15

UK

Australia

Japan

OECD

US

Government Expenditure on Goods & Services (per cent of GDP)

AustraliaTotallyplannedeconomy

Totallyfree-market

economy

N. Korea

N. Korea

Cuba

China

Poland

Poland France

FranceUK

UKUS

US

Early 1980s

Early 2000s

Classifying Economic Systems

China HongKong

CubaHongKongAustralia

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Nature of Economic Transformation

– The shift towards a market-based economic system typically involves at least three distinct activities: 1. Deregulation 2. Privatisation 3. Development of institutions

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Managerial Implications• Political changes of last 20 years has opened

markets to business• Many national markets of may still be

undeveloped and impoverished, but they are potentially enormous

• The Chinese market alone is potentially bigger than that of the United States, the European Union and Japan combined.

• What managerial, social and political skills are required in this new environment

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Managerial ImplicationsBenefits–country’s resource endowments, both

created and natural –its location, either by proximity to its

markets or essential resources.–By identifying and investing early in

potential future economic stars, firms may be able to gain first mover advantages and establish loyalty and experience in a country.

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Managerial ImplicationsCosts• Macroeconomic instability • International competitiveness• Redistribution of Income• Policy Initiatives• Risks

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Overall Attractiveness– overall attractiveness of a country as a potential

market and/or investment site depends on balancing the benefits, costs and risks associated with doing business in that country.

– Generally, the costs and risks associated with doing business in a foreign country are typically lower in economically advanced and politically stable democratic nations and greater in less developed and politically unstable nations.

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1-47

1. Your firm is sourcing its products from a country that for the foreseeable future is likely to experience relatively high rates of inflation and increasing current account deficit balances. Identify the risks to which your firm is exposed and suggest strategies to minimise these exposures. 2. The Nobel Prize-winning economist Amartya Sen argues that the concept of development should be broadened to include more than just economic development. What other factors does Sen think should be included in an assessment of development? How might the adoption of Sin’s views influence government policy? Do you think Sen is correct that development is about more than just economic development? Explain.

Critical Thinking